State Telecom Legislation: Broken Promises NATOA Conference New Orleans, Louisiana September 28, 2012 Gabriel Garcia Assistant City Attorney City of San Antonio
Overview Past Incumbent telecom companies failed to keep their promise to deploy fiber networks after states granted incentive regulation in the 1990s. Present After many states deregulated the cable industry to encourage video competition between the telecom and cable industries, AT&T and Verizon are now abandoning plans to further deploy FTTC (U-Verse) and FTTH (FiOS) networks as they aggressively push customers to their wireless services, and cede parts of the broadband market to the cable industry. Future Telecom companies are lobbying state legislators to pass laws removing the provider of last resort (POLR) obligation and prohibiting local governments from deploying broadband networks. 2
Past Broken Promises The History, Financial Commitments and Outcomes of Fiber Optic Broadband Deployment in America: 1990-2004 The Wiring of Homes, Businesses, Schools, Libraries, Hospitals and Government Agencies, New Networks Institute, December 2009. During the 1990s, most states passed incentive regulation laws capping the rates for basic telephone service, but allowing ILECs to charge market rates for competitive services, including bundled service packages. In exchange, the ILECs (AT&T, Verizon & Qwest) promised to deploy statewide fiber networks capable of 45 Mbps speeds in both directions Fiber to residential and business customers New Jersey (Verizon) Fiber to all schools, libraries and hospitals Texas (AT&T) 3
What Did the Telcos Promise? In the early 1990s, ILECs promised to spend over $53 billion in fiber network deployments in order to connect 46 million residential subscribers with broadband speeds of 45 Mbps (bi-directional) by the year 2000. With this information superhighway telcos would compete with the cable industry. These announcements were intended to promote passage of state incentive regulation laws. Sources: AT&T, Verizon and Qwest Annual Reports and Announcements. RBOC, GTE & SNET Projected Broadband Subscribers, 1994-2000 Carrier Total by 2000 Ameritech 6,000,000 Bell Atlantic 12,000,000 BellSouth 5,600,000 NYNEX 5,000,000 Pacific Telesis 5,500,000 Southwestern Bell 5,600,000 US West 2,600,000 GTE 2,800,000 SNET 1,000,000 Total 46,100,000 4
What Did the Telcos Deliver? By the year 2000, the telecom industry had deployed zero fiber connections to residential customers and instead delivered much slower ADSL service which was counted by the FCC as broadband for an industry broadband delivery percentage of 3.9% compared to projections. Projected Fiber Connections Compared to Reported ADSL Connection (2000) Carrier Projected Fiber Connections Reported ADSL Connections Broadband Percentage Achieved AT&T 23,770,000 982,000 4.1% Verizon 19,800,000 540,000 2.7% Qwest 2,600,000 255,000 9.8% Total 46,100,000 1,777,000 3.9% 5
What Did the Industry Get in Return for Its Promises? By the year 2000, over 75% of states had adopted price-cap regulation, exclusive of other forms of incentive regulation which include revenue-sharing and revenue-cap programs. Only a small minority of states continued with rate-of-return regulation. 6
Impact of Incentive Regulation in Texas 2011 Report to the 82 nd Texas Legislature Scope of Competition in Telecommunications Markets in Texas, Public Utility Commission of Texas, January 2011 ( 2011 Scope of Competition Report ) The legislative report of January 1, 2009 indicated that rates for basic local telephone service would be increasing over the next few years in exchanges where [] rates had been completely deregulated after January 1, 2007. That has in fact been the case for the largest telephone company in Texas [AT&T]. Over the next two years basic telephone service rates in exchanges served by the four largest incumbent telephone companies in the state are expected to continue to increase to offset the reduction in support received by these companies from the TUSF [Texas Universal Service Fund]. Vertical Service rates are not capped under [state law]. Thus, the rates of many of the most popular vertical features have generally continued to increase. The most popular vertical services include Caller ID Name and Number, Automatic Call Blocking, Call Forwarding, Speed Calling, Call Return and Three Way Calling. 7
Lesson from Incentive Regulation Kushnick s Law A regulated company will always renege on promises to provide public benefits tomorrow in exchange for regulatory and financial benefits today. J. Wellington Wimpy I'll gladly repay you Tuesday for a hamburger today. Wimpy s Telecom Law I ll gladly deploy a fiber network tomorrow in exchange for deregulation today. 8
Present Broken Promises In the mid-2000s, the telcos began to argue for cable deregulation in the form of statewide video franchising reform eliminate municipal cable franchise agreements in exchange for statewide video franchises. Key arguments in favor of statewide video franchising: Lower prices resulting from competition Modernization of video infrastructure argument took several forms: Deregulation is needed in order to unleash investment in network Deregulation will result in statewide broadband network Network build-out will close the digital divide Network build-out will create jobs 9
What Did the Telcos Promise? Deployment of Fiber Networks The telcos promised infrastructure investment to deploy statewide broadband networks in order to compete with cable companies. Verizon began deployment of its fiber-to-the-home (FTTH) network FiOS. AT&T unleashed deployment of its fiber-to-the-curb (FTTC) network U-verse. Both of these networks delivered the triple play voice, data, and video services. Qwest (SuddenLink) has been late to the table, but has made similar promises. Competition Telcos promised to compete head-on with cable companies. New Jobs All telcos promised to create new jobs. 10
What Has Verizon Delivered? Stop FiOS Build Out In December 2011 Verizon announced it would stop deployment of its FiOS network beyond the scheduled build out within the next two years. Collaborate Not Compete The news to stop FiOS deployment came on the heels of the announcement that Verizon had reached a spectrum swap and marketing deal with Comcast, Bright House, and Time Warner. Verizon reached a similar marketing deal with Cox Communications. The deal will allow the cable companies to market Verizon s 4G LTE wireless service as part of a bundle of services. Verizon is collaborating with the cable companies by making a basic trade wireless spectrum in exchange for a non-compete clause. Eliminate Jobs By the end Q2 2012, Verizon had 88,600 wireline employees, down from 93,200 a year earlier a 10.5% reduction in one year. 11
What Has AT&T Delivered? Stop U-verse Deployment In May 2011, AT&T confirmed that by year s end it would stop further U-verse deployment. U-verse, with 30 million homes passed, covers about 55-60% of AT&T s service area Verizon covers about 60% of its customers with FiOS. AT&T has begun sending notices to DSL customers within its U-verse footprint informing them that they must make arrangements within 45 days to upgrade to U-verse service. Not Competing with Cable Outside U-verse Footprint In areas not covered by U-verse, AT&T is offering low-price DSL special promotions (instead of deploying U-verse) conceding that it cannot compete with cable modem broadband speeds. Eliminate Jobs In California, AT&T reduced its workforce from 288,660 in Q2 2009 to 260,690 in Q1 2011 a 9.7% reduction in less than two years. 12
Why Have Verizon & AT&T Abandoned Network Build-Out? Cherry Picking Complete AT&T and Verizon have deployed their broadband networks in the areas that will result in the highest average revenue per unit (ARPU). AT&T CEO Randall Stephenson in 2011: Our U-verse build is now largely complete, so we have in place an IP video and broadband platform that reaches 30 million customer locations, which gives us significant headroom now to drive penetrations. FiOS revenues now accounts for 63% of Verizon s total consumer wireline revenues. During the Q2 2012, Verizon s ARPU increased to more than $149, up from $146 the year before. This was the result in part of price hikes during Q2 for FiOS bundles by $10-$15 for most customers while increasing Internet connection speeds. Verizon also raised lease fees for FiOS TV DVRs and set-top boxes in several markets. Verizon and AT&T are shedding DSL connections, but replacing them with broadband connections in areas where they have deployed FiOS and U-verse. In Q2 2012, Verizon lost 132,000 DSL lines, but gained 134,000 new FiOS broadband customers for a net gain of 2,000. 13
Why Have Verizon & AT&T Abandoned Network Build-Out? (Continued) No Broadband Solution for Rural and Low-Income Areas The telcos do not have an economical broadband solution for rural and low-income urban areas. AT&T CEO Randal Stevenson in 2011: And we ve all been trying to find a broadband solution that [is] economically viable to get out to rural America and we re not finding one to be quite candid. This argument can be extended to low-income urban areas where AT&T has not deployed U-verse. DSL connection speeds cannot compete with DOCSIS 3.0 cable modem speeds in areas where they have not deployed U-verse and FiOS. AT&T CEO Stevenson has publicly said that DSL is obsolete. It s not that AT&T and Verizon do not have the resources for a broadband network upgrade in rural and low-income areas, they lack the long-term investor patience for such projects. In other words, such network upgrades are not economical in the short-term to meet investor expectations. In spite of not having a broadband solution for rural and under-served areas, the telcos support state legislation to prevent local governments from deploying broadband networks. 14
Why Have Verizon & AT&T Abandoned Network Build-Out? (Continued) Focus on Wireless Growth AT&T and Verizon are focusing their capex investment to wireless 4G LTE network upgrades where customer growth is healthy. In Q2 2012, Verizon added 1.2 million new wireless customers finishing the quarter with 94.2 million retail customers, a 4.9% increase year over year. Wireless service is emerging as a substitute for providing service in areas where they have not deployed U-verse and FiOS. AT&T and Verizon are pressing state legislatures to remove the obligation of provider of last resort in deregulated markets. So far they have succeeded in four states (Florida, North Carolina, Texas, and Wisconsin) where the telcos may provide wireless or VoIP service as a substitute for low-cost basic telephone service (POTS). 15
What Did the Industry Get in Return of its Promises the Second Time? By 2010, 28 states had passed statewide video franchising. Significantly, some states did not require any network build out (Texas), while others required 50% (California & Michigan), or 65% (Virginia) build out. Several states have passed laws removing the provider of last resort obligation. Several states have passed laws prohibiting local governments from deploying competing broadband networks. 16
Impact of Statewide Video Franchising in Texas Cable prices have increased. The 2011 Scope of Competition Report found: Although the advertising of better prices for packages and term commitments has continued to remain robust, the competition for customers has not resulted in further reductions to consumer prices for the packages and bundles. In most cases, competition has resulted in competitors offering more for the same price (e.g., more features, larger calling scopes, more channels, higher bandwidth). A survey of cable prices in 25 Texas cities conducted by TATOA in 2007 reached the same conclusion statewide video franchises does not result in lower cable prices. The law has had a positive impact on small communities in terms of service availability. In 2006, out of 254 counties in Texas, 22 counties had no broadband provider. By 2010, all counties had at least one broadband provider and 200 counties had at lease one video provider. 17
Lessons from Incentive Regulation and Statewide Video Franchising Telcos repeatedly renege on promises they make in exchange for deregulation because they are acting like rationale profit maximizing firms and regulators do not punish them for their transgressions. While operating in a monopoly market (pre-deregulation) they make promises that can be characterized as providing public goods or advancing the public interest, such as: (1) investment in statewide fiber networks, (2) new jobs, (3) competition, and (4) lower prices. But once deregulation is granted, they make decisions to maximize profits. Those decision put them at odds with the promises they made. The public goods become positive externalities or outcomes that either diminish profits (new jobs) or that have no value to the firm (building fiber network in rural and low-income areas). Therefore, if allowed by regulators they shed jobs and cherry-pick network deployment (or worse deploy no fiber networks). 18
Lessons from Incentive Regulation and Statewide Video Franchising (Continued) Why telcos renege on promises continued: After deregulation, these firms operate in an oligopoly market, where the firms exercise market power and can collude if that is in the best interest of all market participants. Thus, they all increase prices across the board, even as they provide lower introductory rates; collaborate with each other when it is mutually beneficial instead of competing (spectrum swap and marketing deals); and cede market areas to each other rather than compete head-on by deploying new network (DSL is obsolete in the face of DOCSIS 3.0 cable modem service). In the face of diminishing returns (POTS and DSL service) the firms reduce their exposure (by eliminate provider of last resort obligation), close under- and un-served markets for future growth (by preventing local governments from deploying broadband networks), and focus on positive profit centers (wireless broadband service). 19
Implications of Lessons for States that Have Not Adopted Deregulation Recognize that once deregulation is passed, the telcos will operate as profit maximizing firms and will renege on public interest promises if not compelled to deliver on those promises by regulators. State laws that remove the provider of last resort obligation and prevent local governments from deploying broadband services are destructive to rural and under-served communities where the industry has conceded that it does not have a viable broadband solution. Firms in an oligopoly market exercise market power in two ways: They can collude to increase prices. Thus, deregulation will not necessarily lead to lower prices. They have an incentive to exercise control over their networks to create obstacles for competing application broadband providers. Failure to develop safeguards against such activities will diminish competition further reducing the opportunity for lower prices. 20